Why Marxist Economics Doesn’t Work

“Marx forgot about human nature”. This phrase has become so popular among critics of Marxism that it has become a meme. Or maybe it is just popular among ironic Marxists. It’s impossible to judge sincerity on the internet nowadays, as Poe’s Law suggests.

However, like most common sayings about Marxism, the phrase is wildly inaccurate. Even so, Marxist economics is indeed flawed, but for entirely different reasons. But let me deal with this ‘human nature’ meme first.

The meme is meant to imply that human nature is essentially selfish, and that Marx fails to account for this. It also is meant to imply that socialism and communism are based upon altruism, which is incompatible with human selfishness. I suppose there is also an assumption that economists are now aware of human selfishness, whereas Marx was not.

However, first, Karl Marx wrote plenty about human nature. In fact, human nature — or ‘species-being’ as Marx calls it — is a central concept in his early writings. Furthermore, Marx does not assume that humans are altruistic. Rather he argues that humans, unlike other animals, collectively create their own nature. We collectively decide how to arrange our societies, which in turn influence how we behave.

Admitedly, this view of human nature assumes a high degree of human plasticity. In other words, it assumes that nurture is considerably more important than nature, and that humans would be altruistic in the right conditions. Critics of Marx’s early writings could therefore argue that humans wouldn’t be completely altruistic, even in a perfect society. But this criticism would not impact Marx’s later writings, in which his idea of ‘species-being’ fades into the background.

The later Marx is much more concerned with economics, or ‘political economy’, as it was called in the 19th century. In these later writings — which include Marx’s magnum opus, ‘Das Capital’ — he attempts to provide a theoretical and historical account of the capitalist economic system.

As several scholars have argued, Marx does not abandon his view of human nature in these later works. For example, Steven White and Norman Geras have argued that Marx’s theory of human nature complements his theory of capitalist exploitation.

But one thing is clear: Marxist economics are not dependent on any particular view of human nature. In fact, one could consistently view humans as completely selfish and still advocate Marxist economics. Indeed, the economist John Roemer has done just that, creating an unorthodox version of Marxist economics grounded on assumptions of rational self-interest.

As for the idea that socialism and communism depend on altruism, that has very little to do with Marxist economics. Marx himself wrote next to nothing about socialism or communism. His most famous sayings on those systems are from ‘Critique of the Gotha Programme’, a 29 page essay. On the other hand, Marx wrote a LOT about capitalism. ‘Das Capital’, which is Marx’s central writing on capitalism, was left unfinished at 1134 pages!

Following this trend, Marxist economists — at least those in the English-speaking world — have spent most of their time analysing capitalism. So while we could argue that socialism and communism require altruism, that is not a good critique of Marxist economics.

We could also mention that not even mainstream economists believe that human beings are selfish. The most popular school of economics today, neoclassical economics, is well-known for creating theoretical models in which human beings are rational and self-interested. But as those economists frequently point out, their models are not supposed to mirror reality. They are just supposed to simplify reality enough to make predictions. So, in fact, neoclassical economists refrain from making any comments on human nature.

Thus, the failures of Marxist economics have nothing to do with Marx’s ‘forgetting human nature’. Marx wrote extensively about human nature, and clearly did not assume human altruism. Rather, he saw human beings as highly conditioned by their social environments. Furthermore, just like neoclassical economics, Marxist economics are not dependent on any particular view of human nature.

Most critics of Marxism are simply interested in ideological point-scoring. As such, their actual understanding of Marxism is shallow.

Unfortunately, Marxists themselves also engage in ideological point scoring, and are therefore reluctant to admit flaws in their economic analysis. This is a shame, because Marxist sociology and history are now more relevant than ever. The capitalist class is now global in nature, and is quickly destroying the planet. But, in its current state, Marxist economics cannot help us analyze capitalism or imagine alternatives.

The true flaw in Marxist economics is one of its most fundamental ideas: the Labor Theory of Value (herein LTV). Nearly all of Marxist economics is built on top of this single idea. Thus, a problem with the LTV is really a flaw in the whole of Marxist economics.

Marxists themselves are aware that the LTV creates problems. Thus, for over a hundred years, Marxist economists have been trying to create solutions for those problems. However, I would argue that, while Marxists may be able to dodge some of these problems, several of the problems are fatal, and the proposed solutions for them are insufficient. So let me firstly explain the LTV, before explaining the problems with it.

The LTV says this:

The economic value of a good or service is determined by the socially-necessary labor time required to produce it.

I will give you an example to explain this theory. Let’s say that there are two goods in an economy: hammers and pickles (thanks to my autocorrect for that one). Imagine that it takes an average of two hours work to make a hammer in our society, but only one hours work to make a pickle. In that case, the LTV would say that the value of a hammer is twice the value of a pickle.

This simple and intuitive theory lays the foundation for the rest of Marxist economics. Using the LTV, Marxists claim to be able to prove that capitalists exploit and rob workers. Many also claim to be able to prove that capitalism is suffering from a long downturn in profitability, that will inevitably continue and ultimately cause the collapse of capitalism. I will not explain all of these theories here. I merely mention them in order to show how important the LTV is to Marxist economics.

The LTV raises some obvious questions, many of which were addressed by Marx himself. For example, what if you’re a slow worker, and it takes you two hours to make a pickle? Is your pickle worth the same as a hammer? No, argues Marx, because what counts is the ‘socially necessary’ labor time, not the actual labor time. The ‘socially necessary’ labor time is the average time it takes to make the product given the current level of technological development.

Another commonly-raised problem is that of skilled labor. Goods produced by highly-skilled labor cost more than goods produced by regular labor, even if the labor times are the same. For example, let’s compare a master carpenter with their apprentice. We could imagine that each of them take five hours to make a chair. But, one could argue, those chairs would not be worth the same, because a master’s labor is worth more than an apprentice’s.

Marx himself was aware of this problem too. In response, he argued that capitalism tends to eradicate the differences between ‘skilled’ and ‘unskilled’ labor. He argues that, in capitalism, goods tend to be priced on the basis of how long it would take the ‘average’ worker to make them. This means that differences in skill between workers do not tend to factor into prices in capitalism. Thus, the LTV manages to avoid this problem by its insistence on the ‘average’ nature of the labor determining values.

A third clear problem that the LTV faces is the existence of supply and demand as determinants of price. It is well-known that prices tend to go up when there is a shortage, but tend to fall when there is an excess. Marx did not deny this. But he argued that supply and demand only cause temporary fluctuations in price levels, whereas socially-necessary labor time determines long-term price levels. Thus, the mere existence of supply and demand pressures do not contradict the LTV.

A trickier issue is whether technology creates value. Let’s say that there is a new machine that can make a hammer in one hour. Does that mean that the hammer and the pickle are now worth the same?

No, say Marxists, because it took labor to build the machine that makes the hammers. Thus, Marxists argue, machines actually have ‘embodied labor’ in them, and they transfer part of this labor to the products they make, increasing their value. According to Marxists, you calculate the value that machines transfer to each of their products by dividing the total labor used to make the machine by the number of products it will make in its lifetime.

But this solution has its own problems. For example, if machines are used to make a machine, then how do we calculate the value of the produced machine? If production lines became fully-automated, would products become worthless? To the first issue, perhaps you can calculate the embodied labor transferred from one machine to another. To the second, perhaps a fully-automated industry wouldn’t be ‘capitalism’ anymore, due to the non-existence of wage labor. Marx argues that the LTV only applies in capitalism, and, for Marx, wage labor is a defining feature of capitalism.

But as we can see, these questions are starting to chip away at the LTV. What initially looked like a very plausible and simple economic assumption turns out to require intellectual gymnastics in its defense. And yet, there is still a much bigger problem ahead for the LTV.

The big problem can be summed up in the following way. If socially-necessary average labor is the source of all economic value, then labor-intensive industries will be the most profitable industries. However, as Marx observed, the rate of profit tends to equalize in capitalism. Therefore, the LTV contradicts the equalization of profits. This famous problem in Marxism is known as the ‘Transformation Problem’. But there are lots of new terms here, so allow me to explain in more detail.

A ‘labor-intensive’ industry is one that uses a higher proportion of labor relative to machines. On the other hand, an industry that uses a relatively high proportion of machines compared to labor is commonly called a ‘capital-intensive’ industry. For example, if one company employed 10 workers per machine, but another employed 1 worker per machine, the former would be labor-intensive and the latter would be capital-intensive.

As we have seen, according to the LTV, machines do not create any new value in capitalism. Instead, machines just gradually transfer the value embodied in them by the labor originally expended on their production. But, when capitalists buy a machine, they pay in full for the labor expended on those machines. That is because, in accordance with the LTV, the price of any machine is determined by the labor time required for its production. Thus, machines do not create any profit for capitalists; they only transfer the same value that capitalists already paid for.

On the other hand, the LTV says that labor creates all value. Thus, a consequence of the LTV is that labor creates all profit. According to Marx, capitalists create profit by paying workers less than the value they create. For example, let’s say an average worker puts in an 8-hour shift to make pickles. Remember that it takes an hour to make each pickle. The capitalist sells the 8 pickles produced that day, and makes $80 (these are really good pickles). But if the capitalist gave all of this money to the worker, there wouldn’t be any profit. Thus, the capitalist gives the worker a ‘wage’ of, say, $50 for the day, and takes the remaining $30 as profit.

These specific numbers are arbitrary. But the important point is that, according to the LTV, profit is nothing more than a portion of the value created by labor, which capitalists steal from the workers. Marx calls this process ‘exploitation’. But, for now, all that matters is that, according to the LTV, all profit is derived from labor.

From these theories, it follows that the more labor a capitalist employs, relative to machines, the higher their potential profits will be. On the other hand, the more machines a capitalist employs, relative to labor, the lower their potential profits will be.

For example, let’s say that capitalist A pays $1000 for one machine, and $1000 for ten workers, per day. Let’s also say that capitalist B paid $10,000 for ten machines, and $1000 for ten workers, per day. Capitalist A is therefore labor-intensive, while capitalist B is capital-intensive. Let’s say that machines produce 100 hammers per day, and that each hammer sells for $10. At this price for hammers, machines do not add any value; they break even every day, which is what the LTV says should happen. Let’s finally assume that each worker makes 20 hammers per day. This means that each worker produces double their own wages in hammers per day. The capitalists therefore take half of what the workers produce as profit.

In this model, capitalist A has $2000 in expenses per day, and produces 300 hammers per day, which sell for $3000. Capitalist A therefore takes $1000 per day in profit, which gives them a profit rate of 2000/1000, which is 50%. Capitalist B has $11,000 in expenses per day, but produces 1200 hammers per day, which sell for $12,000. Capitalist B therefore also takes $1000 per day in profit. However, this only gives them a profit rate of 11,000/1000, or 11%.

As this example shows, the LTV entails that labor-intensive industries will be more profitable that capital-intensive industries. Even though capitalist B has ten times the machines as capitalist A, that doesn’t increase their profit rate. On the contrary, the extra machines reduce the profit rate, because they create additional expenses without creating new value. Thus, following the LTV, labor-intensive industries will be more profitable than capital-intensive industries.

However, as Marx observed, there is a tendency for the rate of profit to equalize across all industries in capitalism, regardless of the proportion of labor and capital in each industry. This is because capitalists tend to invest in industries with the highest profit rates. As they do so, competition increases in those high-profit industries, causing their prices to fall and their profit rates to drop (at least, according to Marx’s own assumptions about competition). This process continues until all profit rates are equal across industries.

So, we arrive at the famous ‘Transformation Problem’. If labor is indeed the source of all value, why is it that labor-intensive and capital-intensive industries end up being equally profitable? If the LTV is true, then why do the profits of labor-intensive industries start falling when capitalists invest in them? Surely the underlying value created by the workers in those industries has not changed. But the workers’ wages have not increased, so where does the extra value go?

Marx was aware of this problem. In fact, the problem is only called ‘Transformation’ because of Marx’s solution to it. But, in this next section, I will explain how Marx’s solution is insufficient. I will then also explain how other Marxist economists’ alternative solutions are equally insufficient.

Marx’s own solution goes like this. He first makes a crucial distinction between values and prices. The LTV says that labor creates value, and that value ‘determines prices’. Importantly, this means that values are not prices. They are merely causally related to prices. So, following this, when we say that a hammer has the same value as two pickles, we are NOT saying that hammers COST the same as two pickles. We are merely saying that one hammer and two pickles have the same quantity of ‘value’, and that this somehow determines their prices.

So, Marx argues, it is actually market prices that determine profit rates, not values. And it is prices, not values, that fall when capitalists invest in high-profit industries. The values of the products in those high-profit industries remain unchanged. But then, the obvious question is, in what sense do values determine prices, as the LTV claims?

Marx argues that values are ‘transformed’ into prices in the process of capitalist investment and competition. Furthermore, they are transformed in such a way that the profit rate is equalized across all industries. In essence, Marx argues, capitalists share the total value produced by labor between industries. The industries with a higher proportion of labor to machines produce more value, which is then distributed through price competition to those capitalists who invested in industries with lower proportions of labor to machines.

In Marx’s own words,

“Capitalists are like hostile brothers who divide among themselves the loot of other people’s labour.”

Now, critics of this theory have often pointed out that it doesn’t work mathematically. But, for non-economists, I think the bigger concern is that it is extremely counter-intuitive. Why would capitalists want to share the value that they take from workers? Doesn’t that contradict Marx’s own writings on capitalists, who he says maximize their individual profits in competition with each other? And what is the exact process by which competition distributes value, anyway? Despite my best efforts, I have not found satisfactory answers to these questions.

Some contemporary Marxist economists have developed alternative interpretations of the LTV that avoid the Transformation Problem. However, I would argue that these interpretations have their own problems.

For example, Fred Mosley has recently produced an extremely sophisticated interpretation of the LTV in his book, ‘Money and Totality: a Macro-Monetary Interpretation of Marx’s Logic in Capital and the End of the Transformation Problem’.

Mosley’s basic argument is that the LTV is only supposed to be true on an economy-wide level. He says that the total value in the economy is produced by the total labor in that economy. In turn, based on this, the general profit rate of the economy is determined. Only then are prices determined, using the already-determined general profit rate.

In this theory, there is no Transformation Problem, since each product does not have a unique value that we need to transform into its own price. Instead, values are just an economy-wide phenomenon, that only help to determine prices indirectly, via the determination of general profit rates. However, even though this theory avoids the Transformation Problem, it becomes counter-intuitive in its own way.

The LTV is only intuitive because we can easily imagine labor time determining prices. We can easily imagine an economy in which people exchange goods on the basis of how long it takes to make those goods. If it takes people one hour to make a pickle, and two hours to make a hammer, it would seem correct for a hammer to be worth two pickles.

But that intuitive notion disappears in Mosley’s aggregate version of the theory, since prices are not determined by labor time anymore in that theory. Instead, prices are determined by profit rates, which are previously determined by the total labor time in the entire economy. Thus, Mosley’s version sacrifices the intuitive appeal of the original LTV.

This leads us to the most serious problem with the LTV, which is simply this: why should we adopt it at all? We have already seen that the LTV is far from being the common-sense, intuitive theory that it first appears to be. In its original, common-sense form, it leads to multiple problems, including the Transformation Problem. Meanwhile, in Mosley’s aggregate form, it isn’t common-sense at all!

Marxists economists have responded to this problem by saying that economic assumptions don’t have to be intuitive. They argue that scientific theories should be judged on their results, not on their assumptions. For example, David Harvey has frequently defended the LTV on this basis. He admits that Marx offers no ‘proof’ for the LTV, but suggests that we should judge it on the basis of the explanatory power of Marxist economics as a whole.

I disagree. While it is possible to make useful theories on the basis of assumptions, I would argue that there is a limit to how arbitrary those assumptions can be. I would argue that those assumptions need to be independently justifiable for us to be confident that our theory reflects reality at all.

Let me provide a similar case to illustrate why this should be. Theists frequently argue that we can only see God’s power and grace once we have already put our faith in God’s existence. Once you accept the existence of God, they argue, everything starts to make sense, because we can see how things fit into His plan. Now, few people would regard this as a ‘scientific’ theory. Instead, it seems to be a good example of confirmation bias, the tendency to interpret evidence in ways that confirm your existing beliefs.

How can we make sure that our assumptions do not cause confirmation bias? I would argue that our assumptions need to be independently justifiable to avoid this problem. For example, as mentioned earlier, neoclassical economists make the assumption that human beings are rational and self-interested. They justify this on the basis that people often behave roughly in this way, at least in economic affairs. That may or may not be true. But it is certainly more intuitive than ‘aggregate labor in an economy produces total value in an economy’.

For these reasons, I would argue that Marxist economics is stuck between a rock and a hard place. Either the LTV is an intuitive notion that leads to the Transformation Problem, or it is reinterpreted as an arbitrary assumption, which we have no good reason to adopt. But if the LTV is unjustifiable, then the whole of Marxist economics crumbles.

Let me finish by making some remarks on what could possibly replace Marxist economics, given its fundamental flaws.

There are a wealth of Marxist histories that are not dependent on the Labor Theory of Value. Historians such as Eric Hobsbawm, Edward Thompson, Giovanni Arrighi, Robert Brenner and Ellen Woods have provided us with empirically-grounded accounts of capitalism and class struggles. These accounts help us to understand the dynamics of capitalist exploitation, without any need for quantitative economic theories.

Furthermore, I would argue that Marxist history is compatible with other non-Marxist economic theories. For example, it is compatible with post-Keynesian economics, such as the work of Steve Keen. It is also compatible with neo-Ricardian economics, such as the work of Piero Sraffa.

But perhaps the flaws of Marxist economics should lead us back to Marx himself, especially his theory of ‘commodity fetishism’. As Marx argued, capitalism tends to make us forget that economies are contingent social systems. Whatever economic tendencies may exist within capitalism, they are not eternal ‘laws’. Even if the LTV were true in capitalism, this would be a temporary social arrangement, not a permanent economic fact. To paraphrase Marx, perhaps Marxist economists have merely thought about capitalism, when the point is to change it.

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